Guidelines for Implementing the Interagency Program for ... · PDF fileGuidelines for...

of 32

Guidelines forImplementing the Interagency Program for Supervising the

U.S. Operations of Foreign Banking Organizations(the FBO Supervision Program)

RISK-FOCUSED FRAMEWORK

The FBO Supervision Program is a risk-focused supervisory framework designed toprovide an efficient, rational, and uniform approach for supervising the U.S. operations offoreign banking organizations, particularly those with numerous entities across multiple U.S.supervisory jurisdictions. The Program consists of four integral and interrelated components: (1)understanding the institution; (2) assessing its risks; (3) planning supervisory activities; and (4)determining the overall condition of its U.S. operations. Carrying out this risk-focusedsupervisory program results in the development of nine FBO Supervision Program products,which are listed below under their respective risk-focused Program components.

� Understanding the FBO1. Review of Home Country Financial System2. Review of Home Country Accounting Practices3. Institutional Overview4. Strength-of-Support Assessment (SOSA)

� Assessing the FBO's Risks5. Risk Matrix6. Risk Assessment

� Planning Supervisory Activities7. Supervisory Plan8. Examination Program

� Determining the Overall Condition of the FBO's U.S. Operations9. Summary of Condition and Assignment of a Combined U.S. Operations

Rating

Preparation of these FBO Program products provides the U.S. supervisory agencieswith the means, when applicable, of sharing their risk assessments, examination results, andproposed supervisory follow-up actions. As a result, supervisory efforts can be well-coordinatedwhile avoiding duplication of efforts.

To ensure that an appropriate level of uniformity is achieved for all elements of theProgram, basic outlines for the products dealing with (a) understanding the FBO and (b)determining the overall condition of the FBO's U.S. operations are provided here.1 Each U.S.

1 Please refer to the companion procedural AD letter to this SR letter for guidance relating to theProgram products dealing with (1) assessing the FBO's risks and (2) planning supervisoryactivities, which are cross referenced in SR letter 97-24 and its companion handbook.

of 32

supervisory agency participating in the Program may use judgment in determining whichelements of any product should be emphasized depending upon the situation for a particularFBO, its U.S. operations, and its home country banking and regulatory environment.

UNDERSTANDING THE FBO

COUNTRY PRODUCTS

Two important components of the FBO Supervision Program are the reviews of thehome country financial system and accounting practices for each country with bankingrepresentation in the United States. These reviews provide important reference and backgroundinformation about an FBO's home country environment and financial reporting practices. Asdiscussed earlier, these reviews frequently highlight broad issues that may be factored into theSOSA for an FBO, and consequently influence the supervisory strategy for its U.S. operations.

Review of the Home Country Financial System

This review, which should be prepared for each country with FBO representation inthe United States, consists of the following three separate sub-documents, which, as deemednecessary, may be updated independently with separate as-of-dates. (Please refer to the outlinein Appendix I for details.)

1. Financial System Structure - This section should incorporate information onthe make-up of a country's financial sector, including the types of financialinstitutions allowed, the range of their permissible activities, and any relatedownership restrictions; the current degree and trend of concentration withinthe financial sector; and the current degree and trend of foreign financialinstitution participation in the domestic market.

2. Operating Environment - This section should discuss the following mattersas they may impact the country's banking system: the current economicsituation and outlook, the political environment to the extent that it has asignificant impact on the economic situation, and any systemic banking issues.

3. Bank Supervision - This section should focus on key banking laws, theagencies involved in banking supervision, including their respectiveresponsibilities and the extent of any local interagency coordination; on-siteand off-site supervisory and examination practices; the extent to which thesupervisors receive sufficient information on banking institutions and theiraffiliates that would allow evaluation on a consolidated basis; and thetreatment of problem/failed institutions, also under applicable law.

Review of Home Country Accounting Practices

A review of the significant accounting policies and procedures for each country withbanking representation in the United States should be prepared to highlight significant

of 32

differences with U.S. GAAP and their supervisory implications. At a minimum, the reviewshould cover the following areas: (1) asset valuation; (2) income and expense items; (3)consolidation rules; (4) off- versus on-balance-sheet items; (5) tax considerations; and (6)disclosure rules. (Please refer to the outline in Appendix II for details.)

Institutional Overview

Preparation of the Institutional Overview is a critical step in tailoring the FBOSupervision Program in accordance with the characteristics of the organization. The InstitutionalOverview communicates information pertaining to the institution’s current condition and currentand prospective risk profiles, and also highlights key issues and past supervisory findings. TheInstitutional Overview consists of four components described below (please refer to Appendix IIIfor details):

1. Structure - Includes a description of the FBO’s organizational and ownershipstructure, with comments on the legal and business units, and changes throughmergers, acquisitions, divestitures, consolidation or charter conversion sincethe prior review.

2. Business Strategy and Operations - Describes the FBO’s strategy, businessprocesses, and financial performance. It should contain a summary of theorganization’s strategic direction with comments on key business lines,product mix, customer composition, target market clientele, marketingemphasis, growth areas, acquisition or divestiture plans, and new productsintroduced since the prior review. The description of the business processesfocuses on all aspects of risk management, with particular attention given tothe management of concentrations and capital markets activities, including theunderwriting, distribution, and trading of securities and derivativeinstruments, as well as proprietary investment positions. The review offinancial performance will include an analysis of the FBO’s consolidatedcondition, including earnings, capital, asset quality, liquidity, and otherfinancial factors.

3. Funding and Liquidity - Includes an analysis of the depth of local moneyand capital markets, the components of the FBO’s capital structure, and theFBO’s funding sources, reliance on volatile funds, and market ratings.

4. Governance - Assesses the depth and quality of the FBO’s financialtransparency; the independence and usefulness of its outside directors;intercompany lending and intercompany transactions generally; issues relatingto insider lending; the independence and skills of auditors (if possible, ofinternal auditors as well); and the managerial oversight of overseas operations.

of 32

Strength-Of-Support Assessment for Foreign Banking Organizationswith U.S. Operations

Overview

The strength-of-support assessment provides a general framework for evaluating andassimilating significant financial and managerial factors related to an individual FBO as well askey environmental or external factors. The SOSA provides important information to thesupervisory agencies that is taken into account in reaching decisions regarding the scope andfrequency of examinations and other supervisory assessment initiatives. In this regard, theSOSA provides for the efficient utilization of scarce, expert supervisory resources. The SOSAaddresses the overall financial viability of the FBO, as well as several external factors such as thestrength of its management oversight and the degree of supervision the FBO receives from itshome country supervisor.

Factors considered in assigning the ranking include the FBO's financial condition, thesystem of supervision in the FBO's home country, the record of home country governmentsupport of the banking system or other sources of support for the FBO, and any transfer riskconcerns. Therefore, the Review of the FBO's Home Country Financial System and the Reviewof Home Country Accounting Practices, together with the Institutional Overview, serve as theanalytical building blocks for understanding the FBO and deriving the SOSA ranking.

Also included are managerial factors that raise questions about the FBO’s oversight ofits U.S. operations, such as internal controls and compliance procedures at its U.S. operations;and current activities (e.g., a recent merger, significant other expansion or changes in operations,or reported control problems at non-U.S. operations) that may pose a potential risk to the U.S.operations. In assigning the ranking, all relevant factors should be weighed and evaluated. Theassessment ranking is on a scale of "1" to "3" with "1" representing the lowest level ofsupervisory concern, and "3" representing the highest. Standards and criteria for the assessment,including the three possible strength-of-support rankings, are discussed in greater detail below.

Strength-of-Support Assessment Indicators

There are three possible rankings for the strength-of-support assessment:

1. Assessment of "1" - The financial profile and outlook are consistent with a lowrisk that the FBO will be unable to support its U.S. operations. The FBO is viewed asinvestment grade or equivalent, capital ratios are at or above internationally accepted minima,and access to U.S. dollar funding is readily available. There are no material issues related tomanagement oversight of, or support for, its U.S. operations. The home country has a goodrecord of supervising financial institutions and dealing with problem institutions, and transferrisk is not an issue of concern.

An FBO whose financial profile is consistent with an assessment of "1" could beassigned an assessment of "2" or lower if its home country has a supervisory system that islacking in significant respects or significant transfer risk considerations exist.

of 32

2. Assessment of "2" - The current operating performance of the FBO and itsimmediate financial outlook, although not posing significant concerns about the ability of theorganization to honor its U.S. liabilities, may warrant more than normal review based on suchfactors as the lack of an investment grade rating, capital ratios at or below internationallyaccepted minima, or other factors that are considered less than adequate by internationalstandards. Managerial oversight and support of U.S. operations may be lacking in some respects,but are not critically deficient. While the FBO currently may not meet all international financialstandards, the home country has demonstrated an ability and willingness to support the FBO orsimilar financial institutions.

Conversely, the financial profile of the FBO may appear to warrant a stronger ranking;however, supervision by the home country regulator(s) is lacking in material respects orimportant transfer risk considerations exist.

3. Assessment of "3" - Significant financial or supervisory weaknesses are apparent.The FBO may be expected to continue as a going concern due primarily to government support,ownership, or other significant factors, although resource constraints, transfer riskconsiderations, operating structure, or other factors may place important limitations on thatsupport. In the most extreme cases, a seriously deficient financial profile and/or poor operatingpractices, together with the absence of sufficient oversight and support, suggests the possibilitythat the FBO will be unable to honor its U.S. obligations in the near future or is otherwiseconsidered to present a hazard to U.S. financial markets.

Conversely, the financial profile, based on available information, may imply a higherassessment, but home country supervision is deemed to be substantially or wholly deficient, orthere are significant transfer risk concerns.

Strength-of-Support Assessment Factors

Determining whether an individual FBO has the internal or external resources toprovide the necessary financial and managerial support to its U.S. operations depends to a greatextent upon its financial condition, operating record, and general outlook. A good financialcondition combined with capable management is generally sufficient to ensure that support.However, the degree of certainty about the ability of an FBO to provide any necessary financialsupport may be limited by weaknesses in its home country supervisory system, deficiencies infinancial disclosure, or a significant degree of transfer risk associated with its major operations.

Accordingly, the FBO strength-of-support assessment takes into consideration fivefactors:

1. The financial profile of the FBO based on its present financial condition andoutlook, including capital ratios and access to U.S. dollar liquidity;

2. The FBO's home country banking supervisory system;

of 32

3. The demonstrated capabilities of the home country in dealing with bankingproblems;

4. The degree of transfer risk associated with the FBO's home country and any othercountries in which the FBO has major operations; and

5. Any other factors pertaining to the FBO's ability to effectively manage its U.S.operations.

All assessment factors are considered as a whole in assigning the strength-of-supportassessment. None of the factors should be assigned a separate "ranking" or be considered adiscrete component of the final assessment.

The factors used to justify a SOSA ranking will be presented as bullet point comments(as shown in Appendix IV). Full and detailed analysis will be contained in other FBOSupervision Program products, principally, the Institutional Overview and the Review of theHome Country Financial System.

1. Financial Profile - The financial profile of the FBO is based on the institution'scurrent financial condition and outlook. A review of the FBO's financial condition is based onthe level and trend in financial performance indicators relating to the FBO's capital, profitability,liquidity, and asset quality. To the extent possible, these indicators should be evaluated in thecontext of peer performance and knowledge of the FBO's home country financial system andaccounting policies and practices.

The financial outlook should consider a broad range of external and internal factors,such as the home country banking system, systemic banking sector issues, and the FBO'spolitical and economic environment, business strategy, market position, risk matrix, ownership,corporate governance, and management. (Detailed information on these topics is contained inthe Review of the Home Country Financial System and the Institutional Overview.)

Generally, the FBO's short-term and long-term market ratings are good indicators ofits financial outlook. An FBO with the highest market ratings should be able to demonstrate asound financial condition and outlook. The FBO would likely be assigned an assessment of "1"if other factors are consistent with the assessment. Notwithstanding the significance of marketratings, the FBO's financial profile and resultant assessment should not be based on marketratings alone. Rather, the ratings should serve as a reference point for the independentassessment of the institution, because market ratings may not always reflect the most currentview of the FBO, or the supervisory authorities may have information not directly or indirectlyavailable to the market. For example, examination findings of the U.S. operations could raisequestions about the FBO's overall operations and management that could lead to a strength-of-support assessment lower than that indicated by the FBO's market ratings. However, anysignificant difference between the assessment and market ratings should be fully analyzed andjustified. (An FBO's market ratings are contained in the Funding and Liquidity section of theInstitutional Overview.)

of 32

2. System of Home Country Supervision - A review of the home countrysupervisory system is essential to ensure that the FBO is subject to an appropriate level ofsupervision of its global operations. In assigning a SOSA ranking, the review of the system ofhome country supervision should concentrate on the supervisor’s general policies and how thesupervisory framework applies in practice to the individual FBO. In this context, the mereexistence of a home country supervisor is not considered sufficient.

The FBO's home country supervisory system should be evaluated based on thosegeneral principles and practices that ensure monitoring of the FBO's principal operations andactivities, including those outside the home country. These general supervisory principles andpractices usually include some level of periodic reporting, on-site and/or off-site review,prudential guidelines (including capital adequacy requirements), and supervisory enforcementpowers. Effective supervisory systems may take many forms; however, the regulatory system ofany country should ensure that the internationally active banks operating under that system aresubject to a sufficient level of supervision that results in sound oversight of its global operationsand activities.

Supervisory systems may also vary with respect to the type of institution. Therefore,the analysis of the supervisory system should evaluate actual practices as applied to theindividual FBO. This assessment should be based largely on the information that has beenaccumulated over time by the U.S. banking supervisory agencies. It is expected that thisassessment will be enhanced as additional information on supervisory systems is obtainedthrough improved contacts and informational exchanges.

Note that the analysis of Home Country Supervision as applied to the FBO in questionis contained in the Review of the Home Country Financial System.

3. Record of Home Country Support - Related to home country supervision is thematter of the home country's record of ensuring the solvency of its financial institutions,particularly those that operate internationally. This record of support will vary by country withrespect to structure, coverage of banks, resources, and supervisory authority as provided underlocal laws and regulations. Such support may be either direct or indirect in nature and may bewidespread or only applicable to banking institutions with specific characteristics.

Some countries are able to take whatever steps are necessary to support their banksunequivocally, while others will have a more limited degree of support for their banks due tolegal restrictions or financial constraints. These factors should be reviewed, giving particularemphasis to past performance and an assessment of the country's financial resources.

The detailed analysis of home country support also is discussed in the Review of theHome Country Financial System.

4. Level of Transfer Risk - Transfer risk, which relates to the FBO's ability to accessand transmit U.S. dollars, is an essential factor in determining whether the FBO can support itsU.S. operations. For some FBOs, transfer risk is increased due to home country heavy debtservicing obligations or other financial restraints, which, in the past, has led to exchange controls

of 32

and hard currency restrictions in some countries. As a result, these FBOs may have limitedability to provide the necessary support to their U.S. operations.

The assessment of transfer risk for individual countries is uniformly handled by thefederal bank supervisory agencies through the Interagency Country Exposure Review Committee(ICERC). As available, these ICERC assessments should be relied upon in determining the levelof transfer risk for strength-of-support purposes. However, the ICERC rating should not beexplicitly disclosed in the SOSA. For those countries not evaluated by the ICERC, theassessments of transfer risk will be made in the same manner as conducted by the ICERC 2.

Generally, FBOs from countries rated substandard or worse by the ICERC would beaccorded an assessment of no better than "2." However, a high level of transfer risk associatedwith the FBO's home country could be mitigated by other considerations that clearly indicate thatthe FBO has broad access to U.S. dollars.

5. Other Factors - Determining whether an FBO poses any managerial or operationalcontrol risks to its U.S. operations can be influenced by a broad range of qualitative factors. Oneexample of such control risks is an FBO that would otherwise have a strength-of-supportassessment of "1" but may be experiencing certain operational problems, not necessarily in theUnited States. The FBO may be undergoing extensive expansion into new markets or productsthat, over time, could place a strain on its financial and managerial resources. The FBO alsocould be experiencing well-publicized internal control problems at offices outside the UnitedStates. Although these control problems would not necessarily affect the ability of the FBO tomeet its obligations, they may be symptomatic of larger control problems that also might exist inthe U.S. offices. Any such concerns should be explored to the extent possible, particularly asthey may influence the supervisory strategy and examination plan for the FBO's U.S. operations.

Disclosure of SOSAs to FBOs and their Home Country Supervisors

The SOSAs and supporting analyses are for U.S. supervisory use only. Theseevaluations are to be kept strictly confidential by each of the agencies, in part to ensure that thesharing of information between the agencies for purposes of analyzing the condition of the FBOand assigning its strength-of-support assessment will not violate state or federal regulations.

However, the U.S. bank supervisory agencies now have agreed to disclose to eachFBO, and its home country supervisor, its SOSA ranking and a summary of the key pointssupporting the ranking. This step is being taken for three principal reasons: (1) supervisors havedeveloped a high level of confidence in the quality and consistency of SOSA rankings over thepast five years; (2) the rankings have been used to support supervisory decisions requiring a viewof an FBO, such as payment system risk actions; and (3) it is believed that many FBOs havebeen able to derive their SOSA ranking based on the posture taken by U.S. supervisors withrespect to their U.S. operations. Therefore, given the expanded use and importance of the SOSA,the U.S. bank supervisory agencies believe it is appropriate that the SOSA process --specifically, the ranking-- should be made fully transparent to each FBO and its respective home

2 For further information about ICERC’s assessment of transfer risk, see SR letter 99-35.

of 32

country supervisor. As discussed further and shown in Appendices V and VI, the SOSA ranking,and the rationale for the ranking, will be disclosed to the FBO in the Summary of Conditionletter, which is, in turn, transmitted to the home country supervisor via a separate transmittalletter.

ASSESSING THE FBO’S RISKS

Risk Matrix and Risk Assessment of the U.S. Operations ofForeign Banking Organizations

As introduced in this document, the risk-focused framework for the supervision ofFBOs is intended to provide a coordinated, thorough, and efficient approach for supervising theU.S. operations of FBOs that conduct their business in the United States through multipleoperating entities. As such, all operations of an FBO located in the United States, including bankholding companies and commercial banks, should be included in the risk-focused supervisoryprogram for each FBO. Of note is that bank holding companies and commercial banks owned orcontrolled by an FBO should be subject to an individual analysis in accordance with theFramework for Risk-Focused Supervision of Large Complex Institutions (SR letter 97-24) or thecompanion guidance for Risk-Focused Supervision of Community Institutions (SR letter 97-25.)Commercial banks supervised by another federal bank supervisory agency would be subject tothe risk-focused products adopted by that agency.

The products developed for FBO-owned or -controlled bank holding companies andcommercial banks under the risk-focused program for large complex institutions or communityinstitutions should be included as identified items in the products developed for the FBO’s U.S.operations so that, in effect, there will be a complete set of documents for an FBO’s entire U.S.operations on a combined basis. For example, a risk assessment for an FBO that operates (1) abank holding company, (2) several branches and agencies, and (3) a directly-owned Edgecorporation, should include a risk assessment of the FBO’s combined U.S. operations and, withinthe same document, a separate risk assessment for the bank holding company.

PLANNING SUPERVISORY ACTIVITIES

Development of a Supervisory Strategy

As established under the FBO Supervision Program, one of the principal goals of theSOSA is to identify those FBOs that may pose risks to their U.S. operations or to U.S. financialmarkets due to any inherent financial or managerial weaknesses and/or external constraints. Inthis regard, the SOSA ranks all FBOs according to the degree to which they can support theirU.S. operations and the level of supervisory attention these operations may require.Accordingly, the SOSA serves as the initial building block for setting the supervisory strategyfor the FBO's U.S. operations. In conjunction with the Risk Assessment for the FBO’s U.S.

of 32

operations, a strong foundation is created for determining the supervisory activities to beconducted as part of the Supervisory Plan and Examination Program.3

Therefore, the SOSA, together with the Risk Assessment, should strongly influencethe Supervisory Plan and the Examination Program. Ultimately, the SOSA is considered inimplementing supervisory follow-up action for the U.S. operations as well. No automaticsupervisory strategy, however, is mandated. An assessment of "1" generally would imply little ifany concern relating to the ability of the FBO to meet its obligations. If an FBO does raiseliquidity or solvency concerns, the FBO should not be accorded an assessment of "1". Moreover,an assessment of "2" or worse implies a level of concern that would, in many cases, subject theFBO's U.S. offices to at least periodic monitoring of its due from/due to positions. Anyadditional supervisory steps, such as imposing an asset pledge or an asset maintenancerequirement, would be implemented based largely on the condition and nature of the U.S.operations. An FBO accorded an assessment of "3" would indicate a higher level of concern,with a presumption of a net due position or possibly asset maintenance regardless of thecondition of its U.S. operations.

Suggested guidelines for supervisory follow-up action for each assessment categoryare as follows:

Assessment of "1" - Normally, any supervisory follow-up action for FBOs with astrength-of-support assessment of "1" would be applied only if warranted by the condition oftheir U.S. operations. Typically, asset maintenance would not be required for branches andagencies of these FBOs; however, supervisory actions would be undertaken, if necessary, toresolve safety and soundness issues such as deficiencies in risk management, operations andinternal controls, or compliance at any of the U.S. offices.

Assessment of "2" - FBOs in this category may require heightened monitoring offunding sources for their U.S. operations, and of their overall liquidity positions, balance sheetcomposition, growth, and/or other financial factors. The due to/due from position would beclosely monitored and any substantial due from position would be fully analyzed for riskimplications. If warranted by the condition of the combined U.S. operations or the asset qualityat the U.S. offices of such an FBO, asset maintenance would be considered for branches andagencies, and U.S. subsidiary banks could be required to operate at capital levels above theminima.

Assessment of "3" - The FBO would be more closely monitored and may be placedunder continuous surveillance and reporting requirements and/or face supervisory restrictions.For example, there would be a strong presumption of a net due to requirement or possibly assetmaintenance for branches and agencies of an FBO in this category, and U.S. bank subsidiariesshould operate at strong capital levels.

3 The Risk Assessment should apply to the six principal risks, credit, market, liquidity,operational, legal, and reputational, that an institution confronts.

of 32

DETERMINING THE OVERALL CONDITION OF THE FBO’S U.S. OPERATIONS

Summary of Condition and Assignment of a Rating forthe Combined U.S. Operations

An important component of this program is the integration of individual examinationfindings into an assessment of an FBO's entire U.S. operations. At a minimum, following theconclusion of the last examination of an FBO's U.S. operations in a given annual supervisorycycle, a Summary of Condition should be prepared for all FBOs with multiple U.S. operations.(Please see Appendix V for a sample Summary of Condition letter. Please also note that forFBOs whose U.S. operations include a commercial bank supervised directly by the OCC or theFDIC, the Reserve Bank drafting the Summary of Condition should include appropriate languagein the document identifying the primary supervisory agency for the bank, and that agency’sappropriate contact person.) The responsible Reserve Bank, or other U.S. bank supervisoryagency, should prepare an evaluation of the condition of the FBO’s U.S. operations, which willlead to the assignment of a single-component rating between "1" and "5" for those operations ona combined basis.

This evaluation should include an assessment of all risk factors, and (1) all elements ofthe ROCA rating system, (2) quality of risk management oversight employed by all levels ofmanagement in the FBO's U.S. operations, and (3) the examinations of all entities of the FBOconducted during the year. The Summary of Condition and rating of the FBO's combined U.S.operations represent important tools in reaching decisions regarding the scope and frequency offuture examinations and appropriate supervisory measures. This information also should providethe basis for a more efficient utilization of supervisory resources (i.e., recognizing, whereappropriate, a low or high level of supervisory concern for the FBO’s combined U.S. operations).

In arriving at the rating for the combined U.S. operations of the FBO, all of the FBO'sU.S. entities should be considered; however, this rating should not be based merely on anarithmetic average of the examination ratings of the entities examined. The strengths orweaknesses exhibited within individual entities should be evaluated based on their size andimportance relative to the FBO's overall U.S. operations, and the materiality and extent of theweaknesses.

The five ratings are defined as follows:

Combined Rating of "1" - The overall operations are fundamentally sound in everyrespect. They cause no supervisory concern and require only normal supervisory attention.

Combined Rating of "2" - The combined U.S. operations operate in a basicallysound manner, but may have modest weaknesses that can be corrected by management in thenormal course of business. They do not require more than normal supervisory attention.

Combined Rating of "3" - Overall U.S. operations are weak in risk management,operational controls, and compliance, or have numerous asset quality problems that in

of 32

combination with the condition of the FBO cause supervisory concern. U.S. and/or head officemanagement may not be taking the necessary corrective actions to address any weaknesses. Thisrating may also be assigned when either risk management, operational controls, or compliance isindividually viewed as unsatisfactory. Generally, these operations raise supervisory concern andrequire more than normal supervision to address their weaknesses.

Combined Rating of "4" - The combined U.S. operations have a significant volumeof serious weaknesses. Serious problems or unsafe and unsound banking practices or operationsexist, which have not been satisfactorily addressed or resolved by U.S. or head officemanagement. These operations require close supervisory attention and surveillance monitoring,and a definitive plan for corrective action by head office management.

Combined Rating of "5" - The combined U.S. operations have so many severeweaknesses or unsafe and unsound conditions that they require urgent restructuring by headoffice management.

Disclosure

The Summary of Condition is prepared as a letter addressed to the FBO's head officemanagement; it highlights those areas of overall strength and supervisory weaknesses in theFBO's combined U.S. operations. This letter also is used to disclose to the FBO the combinedrating of its U.S. operations and its SOSA ranking. In the event of a mid-cycle SOSA rankingchange, a new Summary of Condition letter should be prepared that discloses the revised SOSAranking and provides updated information on the U.S. supervisors’ view of the FBO's U.S.operations. This information is also transmitted to the FBO's home country supervisor via acover letter. (Please see Appendices V and VI for a sample of each letter.)

RATING SYSTEM FOR U.S. BRANCHES AND AGENCIES OFFOREIGN BANKING ORGANIZATIONS

The rating system for U.S. branches, agencies and commercial lending companies5 offoreign banking organizations is a management information and supervisory tool designed toassess the condition of a branch and to identify significant supervisory concerns at a branch in asystematic, consistent fashion. The rating system (ROCA) was specifically designed to assessthe condition of a branch within the context of the FBO, of which it is an integral part, and topinpoint the key areas of concern in a branch office.

For evaluation purposes, the rating system divides a branch's overall activities intothree individual components: risk management, operational controls, and compliance. Thesecomponents represent the major activities or processes of the branch that may raise supervisory

5 Branches, agencies, and commercial lending companies are hereafter collectively referred to asbranches.

of 32

concern. The rating system also provides for a specific rating of the quality of the branch's stockof assets as of the examination date.

A. Composite Rating

The overall or composite rating indicates whether, in the aggregate, the operations ofthe branch may present supervisory concerns and the extent of any concerns. While theindividual component ratings will be taken into consideration in arriving at the branch's overallassessment, the composite rating should not be considered merely an arithmetic average of theindividual components. The examiner should assign and justify in the report a composite ratingusing definitions provided below as a guide.6

The composite rating is based on a scale of one through five in ascending order ofsupervisory concern. Thus, one represents the lowest level of supervisory concern while fiverepresents the highest level. The five composite ratings are defined as follows:

Composite Rating of "1" - Branches in this group are strong in every respect. Thesebranches require only normal supervisory attention.

Composite Rating of "2" - Branches in this group are in satisfactory condition, butmay have modest weaknesses that can be corrected by branch management in the normal courseof business. Generally, they do not require additional or more than normal supervisory attention.

6 Assessment of asset quality is an integral part of any examination; however, under certaincircumstances, it may be appropriate to give the individual asset quality rating component greateror lesser weight in arriving at an overall composite rating. In ensuring the protection of branchcreditors, an important factor is the strength of the FBO. As the financial strength of the FBOweakens, it becomes increasingly important to look to the quality of the assets booked in theUnited States as the source of protection for local creditors, and, at a certain point, assetmaintenance should be imposed. Similarly, where the FBO is strong, and the need to look tolocal assets for protection of creditors seems remote, the relative weighing of the asset qualitycomponent in the overall evaluation diminishes.

It also should be recognized that different offices of the FBO can be assigned widely differentroles in the FBO's overall strategy. Thus, an individual office that books very few loans, but isotherwise poorly managed should not be given undue credit for having good asset quality.Alternatively, a branch that is designated to hold problem assets generated by other offices of theFBO, in order to better manage the workout process, should not be penalized, so long as the FBOhas the ability to support the level of problem assets.

Finally, it should be recognized that asset quality tends to be a "trailing" indicator of branchperformance. In instances where risk management systems are weak, but problem assets arecurrently nominal, it is realistic to assume there will be future deterioration in asset quality. Bythe same measure, management should be given credit in the overall evaluation where the causesof past asset quality problems have been corrected.

of 32

Composite Rating of "3" - Branches in this group are viewed as fair due to acombination of weaknesses in risk management, operational controls, and compliance, or assetquality problems that, in combination with the condition of the FBO or other factors, causesupervisory concern. In addition, branch and/or head office management may not be taking thenecessary corrective actions to address substantive weaknesses. This rating may also be assignedwhen risk management, operational controls, or compliance is individually viewed asunsatisfactory. Generally, these branches raise supervisory concern and require more thannormal supervisory attention to address their weaknesses.

Composite Rating of "4" - Branches in this group are in marginal condition due toserious weaknesses as reflected in the assessments of the individual components. Seriousproblems or unsafe and unsound banking practices or operations exist, which have not beensatisfactorily addressed or resolved by branch and/or head office management. Branches in thiscategory require close supervisory attention and surveillance monitoring and a definitive plan forcorrective action by branch and head office management.

Composite Rating of "5" - Branches in this group are in unsatisfactory condition dueto a high level of severe weaknesses or unsafe and unsound conditions, and consequently requireurgent restructuring of operations by branch and head office management.

B. Disclosure

Following approval of the rating by appropriate senior supervisory officials at theexamining agency, the composite numeric rating should be disclosed in the open, summarysection of the examination report. In disclosing the rating, its meaning should be explainedclearly using the appropriate composite rating definition. The report should also make it clearthat the rating is part of the overall findings of the examination and is thus confidential. Pendingreceipt of the report of examination, any composite rating disclosed or discussed at anexamination closeout meeting should be clearly conveyed as preliminary by the examiner-in-charge.

C. Component Evaluations

Similar to the composite rating, the individual rating components are evaluated on ascale of one to five, where one represents the lowest level of supervisory concern and fiverepresents the highest. Each component is discussed below followed by a description of theindividual performance ratings.

D. Risk Management

Risk is an inevitable component of any financial institution. Risk management, or theprocess of identifying, measuring, and controlling risk, is therefore an important responsibility ofany financial institution. In a branch, which is typically removed from its head office by locationand time zone, an effective risk management system is critical not only to manage the scope ofits activities, but to achieve comprehensive, ongoing oversight by branch and head officemanagement. In the examination process, examiners will therefore determine the extent to

of 32

which risk management techniques are adequate (i) to control risk exposures that result from thebranch's activities and (ii) to ensure adequate oversight by branch and head office management,and thereby promote a safe and sound banking environment.

The primary components of a sound risk management system are a comprehensiverisk assessment approach; a detailed structure of limits, guidelines, and other parameters used togovern risk-taking; and a strong management information system for monitoring and reportingrisks.

The process of risk assessment includes the identification of all the risks associatedwith the branch's balance sheet and off-balance-sheet activities and grouping them intoappropriate risk categories. These categories broadly relate to credit, market, liquidity,operational, and legal risks.7 All major risks should be measured explicitly and consistently bybranch management; risks should also be reevaluated on an ongoing basis as underlying riskassumptions relating to economic and market conditions vary and as the branch's activitieschange. The branch's expansion into new products or business lines should not outpace properrisk management or supervision by head office. Where risks cannot be explicitly measured,management should demonstrate knowledge of their potential impact and a sense of how tomanage such risks.

Risk identification and measurement are followed by an evaluation of the tradeoffbetween risks and returns to establish acceptable risk exposure levels, which are stated primarilyin the branch's lending and trading policies subject to the approval of head office management.These policies should give standards for evaluating and undertaking risk exposure in individualbranch activities as well as procedures for tracking and reporting risk exposure to monitorcompliance with established policy limits or guidelines.

Head office management has a role in developing and approving the branch's riskmanagement system as part of its responsibility to provide a comprehensive system of oversightfor the branch. Generally, the branch's risk management system, including risk identification,measurement, limits or guidelines, and monitoring should be modeled on that of the FBO as awhole to provide for a fully-integrated risk management system.8

In assigning the risk management rating, examiners should evaluate the current,ongoing situation and concentrate on developments since the previous examination. The ratingshould not concentrate on past problems, such as those relating to the current quality of the

7 While operational risks are identified as part of the branch's overall risk assessment process, theeffectiveness of the branch's operational controls is separately evaluated under ROCA.

8 For a more detailed overview of the risk management process in trading operations, refer to theFederal Reserve's Trading Activities Manual.

of 32

branch's stock of assets, if risk management techniques have improved significantly since thoseproblems developed.9

More specifically, in rating the branch's risk management procedures, examinersshould consider the following points:

� The extent to which the branch is able to manage the risks inherent in its lending,trading, and other activities; specifically, its ability to identify, measure, andcontrol these risks.

� The soundness of the qualitative and quantitative assumptions implicit in the riskmanagement system.

� Whether risk policies, guidelines, and limits at the branch are consistent with itslending, trading, and other activities; management's experience level; and theoverall financial strength of the branch and/or the FBO.

� Whether the management information system and other forms of communicationare consistent with the level of business activity at the branch and sufficient toaccurately monitor risk exposure, compliance with established limits, andsufficient to enable the head office to monitor the real performance and risks ofthe branch.

� Management's ability to recognize and accommodate new risks that may arisefrom the changing environment, and to identify and address risks not readilyquantified in a risk management system.

For example, in the lending area, a branch would be expected to have (1) experiencedlending officers, an effective credit approval and review function, and, where appropriate, creditwork-out personnel; (2) a credit risk evaluation system that was viewed as adequate in assessingrelative credit risks; (3) branch officer lending limits, lending guidelines, and portfolio policiesconsistent with the abilities of branch personnel and the financial expertise and resources of theFBO; (4) a system that identified existing and potential problem credits, a method for assessingthe likely impact of those credits on existing and future profits, and procedures for accuratelyinforming head office of the credit quality of the portfolio and possible credit losses; and (5)procedures for assessing the impact on the portfolio of specific or general changes in thebusiness climate.

A rating of "1" indicates that management has a fully-integrated risk managementsystem that effectively identifies and controls all major types of risk at the branch, including 9 Thus, for example, the change in the level of problem assets since the previous examinationwould normally be more important than the absolute level of problem assets. At the same time, aloan portfolio that has few borrowers experiencing debt service problems does not necessarilyindicate a sound risk management system because weak underwriting standards may make thebranch vulnerable to credit problems during a future economic downturn.

of 32

those from new products and the changing environment. This assessment, in most cases, will besupported by a superior level of financial performance and asset quality at the branch. Nosupervisory concerns are evident.

A rating of "2" indicates that the risk management system is fully effective withrespect to almost all major risk factors. It reflects a responsiveness and ability to copesuccessfully with existing and foreseeable exposures that may arise in carrying out the branch'sbusiness plan. While the branch may have residual risk-related weaknesses, these problems havebeen recognized and are being addressed by the branch and/or head office. Any suchweaknesses will not have a material adverse affect on the branch. Generally, risks are beingcontrolled in a manner that does not require additional or more than normal supervisoryattention.

A rating of "3" signifies a risk management system that is lacking in some importantmeasures. Its effectiveness in dealing with the branch's level of risk exposures is cause for morethan normal supervisory attention, and deterioration in financial performance indicators isprobable. Current risk-related procedures are considered fair, existing problems are not beingsatisfactorily addressed, or risks are not being adequately identified and controlled. While thesedeficiencies may not have caused significant problems yet, there are clear indications that thebranch is vulnerable to risk-related deterioration.

A rating of "4" represents a marginal risk management system that generally fails toidentify and control significant risk exposures in many important respects. Generally, such asituation reflects a lack of adequate guidance and supervision by head office management. As aresult, deterioration in overall performance is imminent or is already evident in the branch'soverall performance since the previous examination. Failure of management to correct riskmanagement deficiencies that have created significant problems in the past warrants closesupervisory attention.

A branch rated "5" has critical performance problems that are due to the absence of aneffective risk management system in almost every respect. Not only are there a large volume ofproblem risk exposures, but the problems are also intensifying. Management has notdemonstrated the ability to stabilize the branch's situation. If corrective actions are not takenimmediately, the operations of the branch are severely endangered.

E. Operational Controls

This component assesses the effectiveness of the branch's operational controls,including accounting and financial controls. The assessment is based on the expectation thatbranches should have an independent internal audit function and/or an adequate system of headoffice or external audits as well as a system of internal controls consistent with the size andcomplexity of their operations. In this regard, internal audit and control procedures shouldensure that operations are conducted in accordance with internal guidelines and regulatorypolicies, and that all reports and analyses provided to the head office and branch seniormanagement are timely and accurate.

of 32

The rating of operational controls should include the following items:

� The adequacy of controls and the level of adherence to existing procedures andsystems. (These are separate but related factors.)

� The frequency, scope, and adequacy of the branch's internal and external auditfunction, relative to the size and risk profile of the branch, and the independenceof the internal audit function from line management.

� The number and severity of internal control and audit exceptions.

� Whether internal control and audit exceptions are effectively tracked and resolvedin a timely manner.

� The adequacy and accuracy of management information reports. This assessmentshould be based primarily on whether reports and analyses are sufficient toproperly inform head office management of the branch's condition on a timelybasis, and whether there are sufficient procedures to ensure the accuracy of thosereports.

� Whether the system of controls is regularly reviewed to keep pace with changes inthe branch's business plan and laws and regulations.

A branch that is rated "1" has a fully comprehensive system of operational controlsthat protects against losses from transactional and operational risks and ensures accuratefinancial reporting. Branch operations are fully consistent with sound market practices. Thebranch also has a well-defined and independent audit function that is appropriate to the size andrisk profile of the branch. No supervisory concerns are evident.

A rating of "2" may indicate some minor weaknesses, such as the presence of newbusiness activities where some modest control deficiencies exist, but which management isaddressing. Some recommendations may be noted. Overall, the system of controls, includingthe audit function, is considered satisfactory and effective in maintaining a safe and soundbranch operation. Only routine supervisory attention is required.

A rating of "3" indicates that the branch's system of controls, including the quality ofthe audit function, is lacking in some important respects, particularly as indicated by continuedcontrol exceptions and/or substantial deficiencies in or failure to adhere to written policies andprocedures. As a result, more than normal supervisory attention is required.

A branch that is rated "4" signifies that the system of operational controls has seriousdeficiencies that require substantial improvement. In such a case, the branch may lack controlfunctions, including those related to the audit function, that meet minimal expectations;therefore, adherence to bank and regulatory policy is questionable. Head office management hasfailed to give the branch proper support to maintain operations in accordance with U.S. norms.Close supervisory attention is required.

of 32

A branch that is rated "5" lacks a system of operational controls to such a degree thatits operations are in serious jeopardy. The branch either lacks or has a wholly deficient auditfunction. Immediate substantial improvement is required by branch and head officemanagement, along with strong supervisory attention.

F. Compliance

In addition to maintaining an effective system of operational controls, branches shouldalso demonstrate compliance with all applicable state and federal laws and regulations, includingreporting and special supervisory requirements. To the extent possible, given the size, riskprofile and organizational structure of the branch, these responsibilities should be vested in abranch official or compliance officer whose function is separate from line management. Branchmanagement should also ensure that all appropriate personnel are properly trained in meetingregulatory requirements on an ongoing basis. The scope of the branch's audit function alsoshould ensure that the branch is meeting all applicable regulatory requirements.

Accordingly, the branch's level of compliance should be rated based on the followingfactors:

� The level of adherence to applicable state and federal laws and regulations andany supervisory follow-up actions.

� The effectiveness of (i) written compliance procedures and (ii) training of linepersonnel charged with maintaining compliance with regulatory requirements.

� Management's ability to submit required regulatory reports in a timely andaccurate manner.

� Management's ability to identify and correct compliance issues.

� Whether the internal audit function checks for compliance with applicable stateand federal laws and regulations.

A branch accorded a rating of "1" demonstrates an outstanding level of compliancewith applicable laws, regulations, and reporting requirements. No supervisory concerns areevident.

A rating of "2" indicates that compliance is generally effective with respect to mostfactors. Compliance monitoring and related training programs are sufficient to preventsignificant problems. Minor reporting errors may be present, but they are being adequatelyaddressed by branch management. Only normal supervisory attention is warranted.

A branch that is rated "3" has deficiencies in management and training systems thatresult in an atmosphere where significant compliance problems could and do occur. Suchdeficiencies could include a lack of written compliance procedures, no system for identifying

of 32

possible compliance issues, or a substantial number of minor or repeat violations or deficiencies.More than normal supervisory attention is warranted.

A rating of "4" indicates that compliance matters are not given proper attention bybranch and head office management and close supervisory attention is warranted. The lack of aneffective compliance program, including an ongoing training program, may be evident alongwith a failure to meet significant regulatory requirements and/or significant, widespreadinaccuracies in regulatory reports.

A rating of "5" would signal that attention to compliance matters is wholly lacking atthe branch to the extent that immediate supervisory action is warranted.

G. Asset Quality

Generally, asset quality is evaluated to determine whether a financial entity hassufficient capital to absorb prospective losses and, ultimately, whether it can maintain itsviability as an ongoing entity. The evaluation of asset quality in a branch does not have the sameresult because a branch is not a separately capitalized entity. Instead, a branch relies on thefinancial and managerial support of the FBO as a whole.

Nonetheless, the evaluation of asset quality is important both in assessing theeffectiveness of credit risk management and in the event of a possible liquidation of a branch.However, as indicated above, a branch is not strictly limited by its own internal and externalfunding sources in meeting solvency and liquidity needs. The ability of a branch to honor itsliabilities ultimately is based upon the condition and level of support from the FBO, a conceptthat is integral to the FBO supervision program.

This concept states that if the condition of the FBO is satisfactory, the FBO ispresumed to be able to support the branch with sufficient resources on a consolidated basis. As aresult, the assessment of asset quality in such circumstances would not in and of itself be apredominant factor in the branch's overall assessment, if existing risk management techniquesare satisfactory. If, however, support from the FBO is questionable, the evaluation of assetquality should be carefully considered in determining whether supervisory actions are needed toimprove the branch's ability to meet its obligations on a stand-alone basis. In cases where abranch is subject to asset maintenance, it is expected that asset quality issues will be addressedby disqualifying classified assets as eligible assets.

The quality of the branch's stock of assets is evaluated based on the following factors.Generally, credit administration concerns should be addressed in rating risk management in lightof:

� The level, distribution, and severity of asset and off-balance-sheet exposuresclassified for credit and transfer risk.10

10 For specific guidance on evaluating the amount of risk inherent in classified assets and off-balance-sheet or contingent exposures, examiners should refer to the Federal Reserveexamination manuals and any applicable supervisory policies.

of 32

� The level and composition of nonaccrual and reduced rate assets.

A branch accorded a rating of "1" has strong asset quality.A branch accorded a rating of "2" has satisfactory asset quality.A branch accorded a rating of "3" has fair asset quality.A branch accorded a rating of "4" has marginal asset quality.A branch accorded a rating of "5" has unsatisfactory asset quality.

H. Assignment of a Combined ROCA Rating

The U.S. bank supervisors will assign a combined ROCA rating for all of the FBO’sU.S. branches, agencies, and commercial lending companies. This composite assessment of riskmanagement, operational controls, compliance, and asset quality at the FBO’s U.S. branch,agency, and commercial lending company operations will in turn be factored into the FBO’soverall combined U.S. operations rating.

of 32

LIST OF APPENDICES

I. OUTLINE FOR THE REVIEW OF THE HOME COUNTRY FINANCIAL SYSTEM

II. OUTLINE FOR THE REVIEW OF HOME COUNTRY ACCOUNTING PRACTICES

III. OUTLINE FOR THE INSTITUTIONAL OVERVIEW

IV. STRENGTH-OF-SUPPORT ASSESSMENT EXAMPLE

V. SUMMARY OF CONDITION LETTER TO FBO MANAGEMENT

VI. TRANSMITTAL LETTER TO THE HOME COUNTRY SUPERVISOR FOR THESUMMARY OF CONDITION

Note: Samples of the products for the risk-focused supervisory process are included in thehandbook on Framework for Risk-Focused Supervision of Large Complex Institutions, which isattached to SR letter 97-24.

of 32

Appendix I

OUTLINE FOR THEREVIEW OF THE HOME COUNTRY FINANCIAL SYSTEM

I. Financial System StructureA. Types of institutions

1. Permissible activities/investments2. Ownership restrictions

B. Concentration of the banking market

C. Existence of financial conglomerates

D. Presence of foreign banks

II. Operating EnvironmentA. Condition of economy and political environment

B. Systemic banking issues

C. Transfer risk

III. Bank SupervisionA. Key banking law(s)

B. Agencies involved in banking supervision

C. Supervisory techniques1. Chartering criteria2. Prudential rules (including an in-depth discussion of capital requirements

and permissible capital components)3. Examinations vs. reliance on external auditors4. Reporting requirements/off-site surveillance5. Corrective measures/sanctions6. Powers of intervention

D. Extent to which supervisor assesses the consolidated worldwide operations

E. Treatment of problem/failed institutions:1. History of government support of individual banking institutions2. Lender of last resort3. Deposit insurance program4. Bankruptcy laws5. Other legal issues

of 32

Appendix II

OUTLINE FOR THEREVIEW OF HOME COUNTRY ACCOUNTING PRACTICES

I. Asset ValuationA. Nonperforming definition/accrual practicesB. Provisioning policiesC. Charge-off policiesD. Revaluation reserves

1. Fixed assets2. Securities portfolio

E. Undisclosed reservesF. Inflation accounting/monetary correctionG. Intangibles/goodwillH. Accounting for subsidiaries and affiliates

II. Income and Expense ItemsA. Provisioning policiesB. Income recognition and accrual methodsC. Inflation accounting/monetary correction

III. Consolidation RulesA. Accounting for subsidiaries and affiliatesB. Accounting for intercompany transactions

IV. Off- versus On-Balance Sheet Items

V. Tax Considerations

VI. Disclosure RulesA. Adoption of internationally accepted accounting standardsB. Financial reporting requirementsC. Comparability to recommended disclosures of the Basel Committee on Banking

Supervision

of 32

Appendix III

OUTLINE FOR THE INSTITUTIONAL OVERVIEW

A significant portion of the information required to complete the SOSA analysis will be found inthe Institutional Overview. The Overview provides a logical, concise assessment of the FBO’sorganization, business strategy, and financial performance. It should be noted, however, that in anumber of developing countries there is limited available information and disclosure. As such,credible information for all of these topics may not be available for all FBOs.

I. Structure - This section should provide background information on the FBO. Informationcontained in this section will not necessarily change substantially from year to year unlessthere is a significant acquisition, divestiture, or strategic reorganization.

A. Description of the FBO (including type of charter) and organization.B. Ownership.C. Comments on key business units, subsidiaries, affiliates, and joint ventures.D. Changes through merger, acquisition, divestitures, consolidation or charter conversion.

II. Business Strategy and Operations - This section should provide information on the FBO’sglobal business strategy, especially as it relates to its U.S. operations; a description of keybusiness lines and major new initiatives as they are introduced; and identification of key riskmanagement issues in pursuit of business objectives.

A. Business strategy: Marketing emphasis, growth areas, acquisitions, and assessment ofmarket position and prospects.

B. Major business activities and related risk management processes: Key business lines;product mix; customers and counterparties for credit products; trading, proprietaryinvestment, and capital markets activities; and other significant business activities, suchas asset management, trust, and custodial.

C. Financial performance and financial outlook: Consolidated financial informationincluding earnings, capital, asset quality, and other financial performance factors; peercomparisons; transfer risk concerns; market reviews; and internal and market-basedprojections, if available.

III. Funding and Liquidity - This section analyses the depth of local money and capitalmarkets; components of the FBO’s capital structure; other funding sources; reliance on, andtypes of, market funding; and credit agency and market ratings.

IV. Governance - This section provides an assessment of financial disclosure; composition,background, and involvement of outside (i.e., non-executive) directors; intercompanytransactions (especially intercompany loans); auditors; and management oversight of foreignoperations.

of 32

Appendix IV

STRENGTH- OF- SUPPORT ASSESSMENT EXAMPLE

Ranking and Rationale:Bank of Country X (BCX) is assigned a Strength-of-Support Assessment ranking of "2" based ondeclining capital ratios, deteriorating earnings, and weakening but better-than-peer asset quality.The ranking is further supported by BCX's uncertain financial prospects following the sector-wide mergers, during which time BCX is expected to absorb much smaller and weakerinstitutions and, as a result, damage its financial condition even further. Generally, externalfactors, such as the home country supervisory system and lender of last support issues, areconsistent with the SOSA ranking of "2." A number of uncertainties for BCX remain,particularly the possibility of increased interference from government shareholders in lendingdecisions.

Given the continuance of the "2" SOSA ranking, no changes to BCX's supervisory strategy arerecommended at this time. (Please see the Supervisory Plan for a full discussion of BCX'ssupervisory strategy.)

Financial Condition:Capital:

Reported total and tier 1 capital ratios of 8.7 percent and 4.1 percent, respectively, areonly slightly above Basel minima.

Asset Quality: Better than the industry average, but markedly affected by the domestic economicdownturn.

Earnings: ROAA declined to 0.5 percent from 0.8 percent prior year, while overhead remains high.

Liquidity:Adequate.

Structure and Governance:BCX possesses a large retail network and conducts a complex range of banking activities.However, the government of Country X has frequently interfered in the lending decisions ofBCX by instructing the bank to lend to government-supported industries. Not surprisingly,BCX was chosen to remain intact in the government’s merger plan and absorb four much smallerinstitutions. The new board of directors will likely retain the former BCX members.

Funding:As the largest bank in Country X, BCX relies on an extensive branch network that providesample and dependable core deposit funding.

Financial System Structure:By year-end 2000, the country’s 15 domestic financial institutions are to be merged into 4 anchorbanks. ABC, one of the surviving institutions, just completed a merger at the end of June 2000.

of 32

Economic and Political Environment:The Country X economy is recovering along with those of its neighbors, driven by exports. Inaddition, the government was reelected for another four-year term, which provides continuity toeconomic policies. There are no transfer risk concerns associated with Country X.

Banking Environment:Government control of the banking sector is absolute, as seen by the central bank’s merger planfor all domestic financial institutions, regardless of ownership type. On the other hand, althoughthe central bank has imposed a 3 percent annual loan growth target since 1998, no banks werepenalized for failing to meet this target.

Bank Supervision:Banks are supervised by the Central Bank of Country X, which requires the approval of theMinister of Finance for certain actions. Although a rigid supervisory structure is in place, rulesand regulations can be, and are, adjusted by the central bank, if advantageous to the country orthe banking system. In all these respects, the two agencies appear to present a united front.Country X bank supervisors have a solid record of supporting troubled financial institutions.

Accounting Issues:In response to the regional economic crisis, the central bank relaxed some accounting standardsfor banks. Separately, bank annual reports must be approved by the central bank prior topublication, so public information may be filtered. For additional information, see the February1999 Country X Accounting System Review.

of 32

Appendix V

SUMMARY OF CONDITION LETTERTO FBO MANAGEMENT

[ADDRESSEE]

(Letter to appropriate head office management of the FBO with copies to appropriatemanagement in the United States responsible for the FBO’s U.S. operations.)

Dear [Name of FBO Official]:

This letter summarizes the Federal Reserve’s Assessment of the Combined U.S.Operations of [Name of FBO ("FBO")] and also provides notification of the Strength-of-SupportAssessment ("SOSA") ranking of FBO.

ASSESSMENT OF COMBINED U.S. OPERATIONS

Scope

(Suggested Text:)

The evaluation of U.S. operations was prepared by the Federal Reserve Bank of XXX("FRBXX"), using the most recent reports of examination and inspection of your bank's U.S.operations, which were conducted as of (coordinated as of date), updated with available financialinformation to (appropriate later date). A copy of this letter also has been sent to FBO's regionalmanagement in (regional headquarters location).

The scope of our review included all banking and nonbanking activities of FBO in theUnited States, and focused on risk management, operations, compliance, and asset quality. Thisprocess involved reviewing reports of examination and inspection of the U.S. operations of FBO;conducting any necessary financial and regulatory analysis; and holding discussions about thecondition of FBO's U.S. operations with other Federal regulatory agencies and Reserve Banks,State Banking Departments, and with staff of the Board of Governors.

Overall Condition

[Indicate overall condition, referencing overall evaluations of risk management,operations, compliance, and asset quality. Cite composite ratings of individual units ifappropriate. Identify weaknesses in critical areas (see below for individual headings). Statewhether these weaknesses are considered correctable in the normal course of business, and if not,cite specific results required to resume satisfactory operations. Conclude with qualitativeevaluation of overall operations.]

of 32

Trading Risk Management

Credit Risk Management

Operations and Audit

Compliance

Asset Quality

Other Matters

[Discuss other matters relating to non-ROCA component ratings of insured banks ornonbanks.]

Combined U.S. Rating

(Suggested Text:)

As noted earlier, we consider the U.S. operations to be [qualitative evaluation.]Specifically, we have accorded a rating of [numeric rating] to FBO's combined U.S. operations.In general, a [numeric rating] rating is assigned when… (See section V, Summary of Conditionand Assignment of a Rating for the Combined U.S. Operations, of this SR letter for theappropriate description of the assigned 1-5 component rating.)

Combined ROCA Rating

The ROCA rating system is designed to assess the condition of FBO's branch andagency network in the United States and to pinpoint the key areas of concern. For evaluationpurposes, the rating system divides the branch network's overall activities into three individualcomponents: risk management, operational controls, and compliance. These componentsrepresent the major activities or processes that may raise supervisory concern. The rating systemalso provides for a specific rating of the quality of the stock of assets as of the examination date.The overall or composite rating indicates whether, in the aggregate, the operations of the branchnetwork may present supervisory concerns and the extent of these concerns. We have accorded arating of [numeric 5 digit rating] to FBO’s branches and agencies [and commercial lendingcompanies if applicable] only on a combined basis.

Corrective Actions

[Describe action taken to date to address weaknesses outlined earlier in theassessment. Acknowledge, where appropriate, any other previous contact, i.e., meetings,conference calls or correspondence, in which these overall findings and corrective action mayhave been discussed.]

of 32

Outstanding U.S. Supervisory Action

[For existing actions, discuss any areas of partial or noncompliance, and relatedremedial action.]

STRENGTH-OF-SUPPORT ASSESSMENT

In assigning the Strength-of-Support Assessment (“SOSA”) ranking, a number offactors are considered, including FBO’s financial condition and outlook, managerial oversight ofits U.S. operations, and factors relating to the home country banking and supervisory systems ofFBO.

The SOSA ranking, which is one element in the development of a supervisory strategyfor the U.S. operations of FBO, is based on a scale of “1” to “3”, with “1” representing thelowest level of supervisory concern and “3” representing the highest. The assessment of FBOresulted in the assignment of a SOSA ranking of [“1,” “2” or “3”]. [Select the appropriatesentence corresponding to the SOSA ranking: (a) In general, an institution assigned a ranking of“1” is a foreign banking organization whose financial profile and outlook pose a low risk that itwill be unable to support its U.S. operations. (b) In general, an institution assigned a ranking of“2” possesses a current operating performance and immediate financial outlook that, althoughnot posing significant concerns about its ability to honor its U.S. liabilities, may warrant morethan normal supervisory attention. (c) In general, an institution assigned a ranking of “3”possesses significant financial or supervisory weaknesses, and a high degree of supervisoryoversight of its U.S. operations may be warranted.] Provide a brief summary of the key pointssupporting the SOSA ranking.

DISCLOSURE

(Required Text:)

Please note that the assessment and rating of FBO's U.S. operations, combined ROCArating, and its SOSA ranking, are parts of the overall findings of U.S. supervisory activities. Thecontents of this letter are subject to the rules of the Board of Governors of the Federal ReserveSystem regarding disclosure of confidential supervisory information. Under no circumstancesshall the bank or any of its directors, officers, or employees disclose or make public in anymanner this letter, the combined U.S. rating, combined ROCA rating, or the SOSA ranking. Acopy of the "The Interagency Program for Supervising the U.S. Operations of Foreign BankingOrganizations", SR letter 00-XX, is available through the Federal Reserve Board's web site.Please direct any questions or comments to [Name of Contact] at [phone number] or [e-mailaddress].

(Signed) Senior Officer for BS&R

cc: Regional U.S. FBO managementBOG Staff

of 32

Appendix VI

TRANSMITTAL LETTER TO THE HOME COUNTRY SUPERVISOR FORTHE SUMMARY OF CONDITION

[HOME COUNTRY SUPERVISORY CONTACT][NAME OF SUPERVISORY AGENCY][ADDRESS][CITY, COUNTRY]

Dear:

The enclosed letter summarizes the Federal Reserve System’s assessment of thecombined U.S. operations, combined ROCA rating, and Strength of Support Assessment rankingof [Name of FBO ("FBO")], and was recently sent by this Reserve Bank to FBO. Thisevaluation reflects the examination findings for the entities operated by FBO, which wereexamined during [year of examination, or as of examination date]. A listing of the entitiesexamined also is enclosed. As a result of these examinations, FBO was assigned a CombinedU.S. Operations Rating of [numerical rating]. An institution whose U.S. operations are rated a[numerical rating] has [definition of the numerical rating]. Furthermore, a combined ROCArating of [numeric 5-digit rating] has been accorded to FBOs U.S. [branches, agencies andcommercial lending companies (select appropriate text)].11

Please take particular note of the following matters of supervisory significance:

[discuss briefly as necessary].

This letter also serves to notify you of the Strength-of-Support Assessment (“SOSA”) forFBO prepared by the [name of U.S. bank supervisory agency]. In assigning a SOSA ranking, anumber of factors are considered, including FBO’s financial condition, managerial oversight ofits U.S. operations, and the condition of the banking system in which FBO operates.

The SOSA ranking is based on a scale of “1” to “3”, with “1” representing the lowestlevel of supervisory concern and “3” representing the highest. The assessment of FBO resultedin the assignment of a SOSA ranking of [“1,” “2” or “3”]. [Select the appropriate sentence

11 The ROCA rating system is designed to assess the condition of FBO's branch and agencynetwork in the United States and to pinpoint the key areas of concern. For evaluation purposes,the rating system divides the branch network's overall activities into three individualcomponents: risk management, operational controls, and compliance. These componentsrepresent the major activities or processes that may raise supervisory concern. The rating systemalso provides for a specific rating of the quality of the stock of assets as of the examination date.The overall or composite rating indicates whether, in the aggregate, the operations of the branchnetwork may present supervisory concerns and the extent of these concerns.

of 32

corresponding to the SOSA ranking: (a) In general, an institution assigned a ranking of “1” is aforeign banking organization whose financial profile and outlook pose a low risk that it will beunable to support its U.S. operations. (b) In general, an institution assigned a ranking of “2”possesses a current operating performance and immediate financial outlook that, although notposing significant concerns about its ability to honor its U.S. liabilities, may warrant more thannormal supervisory attention. (c) In general, an institution assigned a ranking of “3” possessessignificant financial or supervisory weaknesses, and a high degree of supervisory oversight of itsU.S. operations may be warranted.] Provide a brief summary of the key points supporting theSOSA ranking.

The Federal Reserve is providing this supervisory information to you with theunderstanding that your agency will maintain its confidentiality to the extent possible underapplicable law, and that such information will be used only for lawful supervisory purposes.

We have advised FBO that the contents of the letter providing the Federal ReserveSystem’s summary assessment and supervisory rating of its U.S. operations, combined ROCArating, as well as its SOSA ranking, are subject to the rules of the Board of Governors of theFederal Reserve System regarding disclosure of confidential supervisory information, and thatunder no circumstances should the bank disclose or make public in any manner the contents ofthe attached letter.

Please direct any questions regarding this letter to [name of Reserve Bank Official, Title],at [phone number and/or email address].

Sincerely,

Name of Reserve Bank Official][Title]

Enclosures

Guidelines for Implementing the Interagency Program for ... · PDF fileGuidelines for...

Documents

Transcript of Guidelines for Implementing the Interagency Program for ... · PDF fileGuidelines for...